3Com's sale to Bain, Huawei stymied

National-security agency fails to approve $2.2 billion deal

WASHINGTON (MarketWatch) -- Concerns about national security appeared Wednesday to have scuttled the $2.2 billion sale of networker 3Com Corp., whose shares dropped as much as 20% on Wednesday.

Marlborough, Mass.-based 3Com
COMS
and its two partners -- Bain Capital Partners LLC and Huawei Technologies Co. -- said they had withdrawn application with the Committee on Foreign Investment in the United States.

The little-known CFIUS, part of the Treasury Department, monitors the effects of cross-national mergers and can block deals if it believes the nation's security would be placed at risk. Only rarely has the agency taken that step

3Com Chief Executive Edgar Masri said he was disappointed, but he added that the company would work with its partners to "construct alternatives that would address CFIUS' concerns."

In late trading, 3Com's shares fell 20% to $2.98, well below the original buyout offer of $5.30.

The source of the agency's concern is the participation of Huawei, the largest networker in China and a company with links to the mainland's communist government. Huawei is run by a former mid-ranking officer in the Chinese army whose firm has raised the ire of the U.S. government and Western rivals such as Cisco Systems Inc.

Huawei would gain a 16% stake in 3Com, with Bain Capital Partners owning a majority stake. Boston-based Bain was founded by former Republican presidential candidate Mitt Romney, though he's no longer involved with the firm.

It's no longer a top-tier networking company, but 3Com still does substantial business with the U.S. The vendor's TippingPoint subsidiary, for example, sells anti-hacking and other network-security services to the Defense Department.

The U.S. has been particularly sensitive about foreign ownership of networking and communications assets, especially in light of repeated attempts to hack the nation's defense systems. Chinese-based hackers are viewed as a major concern.

Political hot potato

The failure to win U.S. clearance also occurs during an election year, in a political climate in which foreign trade and the actions of China have become hot-button issues.

Politicians in both parties have expressed concern about Chinese companies buying stakes in domestic firms, complaining that the Chinese market is not fully open to Western participation.

Some also believe Huawei has been working with its government to undermine Western interests. Several years ago, for example, the CIA reported that Huawei illegally sold communications equipment to Saddam Hussein before his Iraqi government was overthrown.

Last fall, Rep. Ileana Ros-Lehtinen, the ranking Republican on the House Foreign Affairs Committee, co-sponsored a bill to block the sale of 3Com. A handful of other Republicans joined her.

U.S. and European rivals of Huawei, for their part, have also felt the sting from Chinese upstarts, whose low prices have forced Western vendors to reduce costs. Cisco
CSCO, +0.12%
has even accused Huawei of stealing its router technology.

For Huawei, the 3Com deal would give the Chinese vendor a bigger position in the U.S. and European markets and help it compete with traditional leaders such as Cisco, Alcatel-Lucent
ALU, +0.60%
and Nortel Networks
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A major player in the networking market in the late 1990s, 3Com has struggled to grow its business in recent years. Yet sales surged in 2007, thanks in part to the success of its Tipping Point subsidiary and a Chinese venture that 3Com once operated in tandem with Huawei.

The venture was started in 2003, but 3Com bought out its Chinese partner last year.

In 2007, 3Com generated $1.27 billion in revenue, up 59% from $795 million the year before.

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